The Lame “Uncertainty” Defense

By James Kwak

The indefatigable Brad DeLong has devoted his energies to singlehandedly protecting Larry Summers from the Internet (although, he makes pains to say, he likes Janet Yellen almost as much). Although I’m letting most of the Fed chair sideline debate pass me by, DeLong and others have raised one issue that played an important symbolic role in 13 Bankers and, more generally, the historical background to the financial crisis: Brooksley Born’s proposal to think about regulating OTC derivatives in 1998.

For those who don’t know the story, it basically goes like this. Born, as chair of the CFTC, was worried about the risk posed by OTC derivatives, which were effectively unregulated at the time. On May 7, 1998, the CFTC issued a “concept release”  asking for comments about the regulation of OTC derivatives. Summers, then deputy treasury secretary, along with Treasury Secretary Robert Rubin, Fed Chair Alan Greenspan, and SEC Chair Arthur Levitt, opposed Born, and they issued their own press release on the same day opposing the CFTC. Over the next several months they successfully blocked the CFTC from regulating OTC derivatives, convincing Congress to stop the CFTC from moving forward, a position that was enshrined in statute in the Commodity Futures Modernization Act of 2000.

Now that it is widely recognized that OTC derivatives needed to be regulated, this has been an uncomfortable bit of history for Summers et al. The current defense was put forward by an unnamed person and by DeLong:

One person close to the process described it this way: “The concern with Born’s concept release back then was that CFTC jurisdiction rested on the contracts being futures contracts, and if they were futures contracts, they had to be exchange traded, and existing hedging contracts were not exchange traded (at the time they basically couldn’t be), so there was a concern that the existing contracts would be void (illegal).” . . . Cal Berkeley professor J. Bradford DeLong, who has authored papers with Summers, Tweeted last night: “‘Brooksley Born approach’ made all existing derivatives contracts unenforceable. Very bad idea.”

There are several problems with this defense.

First, this argument targets one possible outcome of Born’s process, not the process itself—which is what Summers et al. shut down. The purpose of the concept release was “to solicit comments on whether the regulatory structure applicable to OTC derivatives under the Commission’s regulations should be modified in any way . . . and to generate information and data to assist the Commission in assessing this issue.” Born wanted to discuss the issue. Yet her opponents then—and now—jumped to the “worst” possible outcome (for them, or rather for certain market participants) and equated that with what Born was doing.

Second, that isn’t how the law works. It was recognized at the time that OTC derivatives were in a legal gray area—hence the desire for “certainty” that was finally satisfied by the CFMA. If some activity is in a legal gray area, and you do it anyway, you can’t simply assert that now the activity must be allowed by law because you are doing it. If the contracts you wrote, knowing they might not be enforceable, now become definitively unenforceable—well, tough luck. You can’t dictate what the law is simply through your own actions.

Third, the argument proves too much. Again, Born was proposing to think about about whether and how OTC derivatives should be regulated. If that is a “very bad idea,” then, by implication, OTC derivatives can never be regulated—because you have to think about regulating something before you can regulate it. Is that really a position that Summers and DeLong want to defend?

Fourth, if the problem is existing contracts, then there’s an obvious solution: grandfather them. In fact, the concept release included this language:

“This release does not in any way alter the current status of any instrument or transaction under the CEA. All currently applicable exemptions, interpretations, and policy statements issued by the Commission regarding OTC derivatives products remain in effect, and market participants may continue to rely upon them.”

It is true that that language applied to the release itself, not necessarily to any regulations that might have been issued later. But those regulations would have to go through the usual notice-and-comment process, and the other regulatory agencies would obviously be at the table. If Summers’s real concern was past contracts, then that’s something he could have negotiated with Born.* (And if she refused, then he could have gone to Congress, or to the courts.) That concern doesn’t justify what happened.

Summers would be better off—at least as far as this Fed chair thing is concerned—simply admitting he was wrong, rather than trying to win a fifteen-year-old argument. At the end of the day, however, the whole Brooksley Born affair is a bit beside the point—if the question is trying to understand Larry Summers. The Summers camp thinks they can justify his anti-regulatory stance during the Clinton years by making Born look like an extremist; by implication, he was just a moderate.

But the Born affair (and, or course, the great “thirteen bankers” quote) is just one piece of evidence. We know that Summers opposed derivatives regulation. The report of the President’s Working Group on Financial Markets with his name on it unanimously recommended providing “legal certainty” by definitively exempting derivatives from the Commodity Exchange Act. He was secretary of the treasury when the CFMA was passed. Robert Rubin said in his 2003 memoir (before he had anything to be embarrassed about), “Larry characterized my concerns about derivatives as a preference for playing tennis with wooden racquets–as opposed to the more powerful graphite and titanium ones used today.” (Rubin now claims that he was in favor of derivatives regulation, although he didn’t do anything about it.)

And it isn’t as if Summers had some other, better proposal to regulate OTC derivatives. He was against it. That’s the issue—not whether the legal status of derivatives contracts under the CEA somehow changed because of a concept release issued by the CFTC.

* This is what Levitt now says he wishes he had done.

58 thoughts on “The Lame “Uncertainty” Defense

  1. A little problem with your (and DeLong’s facts). In 1992 — for the purpose of dealing with financial derivatives, that fell under the Commodity Exchange Act’s definition of futures — the CFTC was given the legal authority to exempt certain contracts from regulation — and under Wendy Gramm promptly exempted the derivatives in question. There was no legal question as to whether these contracts fell under the jurisdiction of the CFTC. The only question was whether the CFTC would continue to exempt them entirely from regulation.

    The statement “It was recognized at the time that OTC derivatives were in a legal gray area” is simply false.

    [See comments here,
    “I don’t actually think the financial industry was seriously disputing the CFTC’s legal authority to regulate swaps. Rubin claimed that was his objection, and so did some people in the industry, but in reality they all knew that it wasn’t a serious objection. (All the NY law firms, including mine, told them that the CFTC was well-within its jurisdiction.) It’s kind of pathetic that Rubin claimed to be relying on a memo by Treasury lawyers that apparently never existed.”]

    The uncertainty you reference is a myth created by by opponents of derivatives regulation. The fact that such a myth is cited as fact by educated people such as yourself and Prof. DeLong, who can be cited as experts by people who want to disseminate disinformation, is one of the reasons our financial system is in such bad shape.

  2. Oh, c’mon Brad, don’t be a wimp. Kwak is misrepresenting what happened back in 1999.

    Born was engaged in a power grab regarding foreign currency futures, and to a lesser degree interest rate swaps. Credit default swaps–the ogre, supposedly, in this financial crisis–aren’t even mentioned in the ‘Working Group’ paper linked to above.

    Nor was it a case of the OTC market being ‘unregulated’, just by whom;

    ‘A criticism of OTC derivatives is that they can be used as a means to circumvent regulation. For example, institutional investors may be prohibited from investing in certain types of financial instruments but may be able to assume a nearly identical economic position by entering into a derivatives transaction. The Working Group is aware that the derivatives industry has been quite creative in tailoring particular products to achieve certain regulatory results that were not originally intended. As difficult as the task may be, the Working Group nonetheless believes that in most instances such “regulatory arbitrage” issues should be addressed by
    amending the underlying statutes and regulations that most closely pertain to the regulatory goal to be achieved, and should not be used as a basis for the imposition of an unwarranted regulatory regime on derivatives. For example, judgments about the authority of pension funds or state and
    local governments to enter into certain derivatives transactions should be made through the laws that directly govern such entities.’

    The SEC and banking regulators make more sense here than an agency that was specifically set up to regulate soy beans and pork bellies, no?

  3. Anon, did you bother to read the Working Group paper?

    ‘A cloud of legal uncertainty has hung over the OTC derivatives markets in the United States in recent years, which, if not addressed, could discourage innovation and growth of these important markets and damage U.S. leadership in these arenas by driving transactions off-shore.
    Recognizing the important role that derivatives play in our financial markets, and the dangers of continued legal uncertainty, the Working Group has spent the past six months focusing on OTC derivatives and examining the existing regulatory framework, recent innovations, and the potential for future development. At the request of Congress and the Chairmen of the Senate and House Agriculture Committees, we have prepared the attached report, which reflects the consensus we have reached on a set of unanimous recommendations.’

    Note that, ‘At the request of Congress….’ The paper is quite specific as to what those uncertainties were.

  4. As Econ of Contempt, a long-term securities lawyer, indicates in his comment, such claims, asserted by proponents of financial deregulation, were “based on a memo by Treasury lawyers that apparently never existed”.

    Given Econ of Contempt’s comments, apparently what was going on in the Working Paper report is a complete revision of a well-understood aspect of the law — for the purposes of promoting financial deregulation. Remember that every law is completely uncertain if you are allowed to start parsing the meaning of each word in the law anew, as if there were no existing body of interpretation.

  5. What was going on was a power grab by Brooksley Born–not exactly unknown in DC. The ‘Working Group’ (not the Working Paper) is not calling for deregulation at all, as it notes that the SEC and banking regulators already had authority over most derivatives dealing.

    As for ‘a Treasury memo’, are you saying Phil Gramm was at Treasury? As for parsing the meaning of words, try finding ‘credit default swaps’ anywhere in this;

    ‘Swap agreement means: (i) An agreement (including terms and conditions incorporated by reference therein) which is a rate swap agreement, basis swap, forward rate agreement, commodity swap, interest rate option, forward foreign exchange agreement, rate cap agreement, rate floor agreement, rate collar agreement, currency swap agreement, cross-currency rate swap agreement, currency option, any other similar agreement (including any option to enter into any of the foregoing); (ii) Any combination of the foregoing; or (iii) A master agreement for any of the foregoing together with all supplements thereto.’

    In fact, can you find any mention, anywhere, by Brooksley Born, while she was heading the CFTC, of the term?

  6. In Brooksley Born’s own words:

    “I was told by the secretary of the treasury that the CFTC had no jurisdiction, and for that reason and that reason alone, we should not go forward,” Born says. “I told him . . . that I had never heard anyone assert that we didn’t have statutory jurisdiction . . . and I would be happy to see the legal analysis he was basing his position on.”

    She says she was never supplied one. “They didn’t have one because it was not a legitimate legal position,” she says.

    It’s interesting that no one who signed the Working Group paper that advocated for the CFMA had any legal training.

  7. From the CFTC’s own website;

    ‘February 25, 1997–In Dunn v. CFTC, the U.S. Supreme Court rules that foreign currency options are ”transactions in foreign currency” for purposes of the Treasury Amendment exclusion to the Commodity Exchange Act, and, thus, that the CFTC has no jurisdiction over such transactions.’

  8. It is very ironic to me that although I often disagree, and vehemently disagree, with many of “EconomicsOfContempt” blogger’s opinions and statements, it seems to me that of all the people above (including host James Kwak, whom I usually agree with about 75%+ of the time), it is “EconomicsOfContempt” who is the only one who seems to accurately remember history on this particular topic.

    And please believe me, it really kills me to admit “EconomicsOfContempt” blogger is right about anything……

    After Rubin, Greenspan, and Levitt threatened to beat her up after school if Brooksley dared to perform her job, and grab a year’s worth of Brooksley’s school lunch money if she meekly mumbled the words “swaps/derivatives regulation” in a public forum, Levitt is the only one of the 3 BULLIES of Brooksley Born, who was willing to say 3 words after 2008 made it abundantly clear: “I was wrong”. No “easy feat” for your prototypical super-arrogant J-E-W (take Larry Summers as the baseline example).

  9. Excuse me, I should have said “the 4 BULLIES of Brooksley Born”. I’ve been trying sooooooo hard to forget the supreme A-S-S HAT named Larry Summers, I nearly forgot for the time it took to post a comment.

  10. Most interesting. The DeLong tweet was debunked in real time by @dsquareddigest, and retweeted by DeLong.

    Dan Davies ‏@dsquareddigest 31 Jul
    @delong that was total industry bullshit propaganda about the 98 concept release – if LS believed it at the time that’s a real problem

    Larry Summers Defended Enron…
    Larry Summers Is Also Lousy At Crisis Management…
    The Economy Is Awful and Larry Summers Should Not Be Fed Chair.
    Derivatives and Steroids: Larry Summers Merits Same Fate as A-Roid
    Summers’ View on Monetary Policy Not So Hidden…
    Larry Summers Is An Unrepentant Bully…
    Obama Defends Larry Summers, Disses HuffPost In Capitol Hill Meeting

  12. I read all these comments but I still can’t see the social utility of these financial innovations. Do they contribute to productive economic growth? Or are they just gambling inside a bank? Could someone address these issues?

  13. Anon (above) Great link & very pertinent material @ but the very first comment stands out: [quoted]

    Anonymous said…[to the Author]

    “You’re a lawyer. Presumably you understand that the issue Born was raising with that Concept Release was the CFTC’s obligation under the law to reconsider its 1993 exemption of swaps contracts from regulation given the huge growth in the industry. The financial industry was objecting to the fact under the pre CFMA Commodities Exchange Act that the CFTC had clear legal authority to regulate swaps as it saw fit.

    For more info on this you should read Born’s 1998 Congressional testimony:
    and the recent Stanford profile where Born comments on the debacle:

    The saddest thing about this story is that Born was a regulator who was serious about doing her job well — and the Concept Release is clear evidence of this. What regulations she would have proposed are unknowable — because she was prevented from doing the preliminary study that would have allowed her to design suitable regulations!”
    [In reply the Author concedes]…
    Economics of Contempt said…

    “You’re right, and I meant to address that in my post, but I somehow forgot.”
    There seems to be a good deal of “forgetting” and re-shaping going on here. And I would laugh if it didn’t make me sick to my stomach hearing Brooksley Born now accused of some simplistic revisionist “power grab” for standing firm against the insider power structure that existed at that time and for the most part in new snakeskin… to this day.

  14. @Dryly 41 (hope this helps…from the Real News Network)
    Quadrillion Dollar Derivatives Market 20 Times Global GDP

  15. I’m still waiting for someone to provide some evidence Brooksley Born even knew what a credit default swap was, prior to 2008. She didn’t mention them in her 1998 testimony linked to above. That’s all about LTCM’s foreign currency/interest rate arbitrage. Which was definitely not the problem that caused the 2008 crisis.

  16. If you want a name of someone who did know what problems derivatives of MBS could cause, how about Hank Greenberg, founder of AIG. He refused to get involved in the riskiest of those CDS, refused to pledge collateral (worried about liquidity issues), and even fired the guy he’d brought in from Drexel to create AIG-FP who did want to be more aggressive.

    Then, along comes a real bully; Eliot Spitzer to illegally intimidate the AIG board into dumping Greenberg and replacing him with one of Spitzer’s cronies. That happened in 2005, and that’s the reason AIG needed ‘help’ from the Fed; Spitzer’s guy allowed AIG-FP to go crazy over sub-prime. Since Spitzer had also destroyed AIG’s AAA credit rating, AIG had to pledge collateral for its co-parties. When the crisis hit that collateral wasn’t sufficient, and AIG was illiquid.

    So, there’s your morality play, complete with an actual bully. One who might resurrect his career in NYC politics soon.


    @Paddy, is that the *event* you’re talking about?

    “….when the crisis hit that collateral wasn’t sufficient, and AIG wasn’t liquid….”

    Right, just when it went to “liquid”, literally, that it became illiquid.

    Seriously, what the hell kind of excuse is that to give for the first major city to bite the dust from climate change – that it’s just a blip on your financial screen full of algorithms?

    Does the word “delusional” even exist in your constant reconfiguration of the same 50 words to mean something different every time they’re used?

    Throw it in there – see what happens to the virtual control of conversation…

    Just up for grabs in a way you’ll never catch on to, Paddy….anyone can win.

    But if you want some woman to football around, psychologically, why not the Governor of Louisiana at the time Katrina hit. She was so sincerely dumb when presuming on the protection of God without doing anything smart like “…get out and into higher ground…” that it seemed smart at the time.

    Not fair what you are doing to Born and even worse, you are doing it using omission of the facts in the timeline.

    Don’t matter who got a piece of you, CIA, DEA, IRS, FBI, and on and on in the perpetual war machine, you go back to lay a trap for a different game. One in which they are the prey. Really sick sht out there, man. Zombies…

    Blood lust for money – where do we go – in the MILLIONS – to get away from their reach? That’s what everyone is asking….this is epic in it’s re-arrangements of of tribes down the timeline to the “Now” we all have a piece of that molecule of time in this planet space…by the time you own it all, the way you got it all will destroy it all.

    Go figure….

    Arnold & Porter LLP
    Brooksley Born is a retired partner of the firm, which she joined as an associate in 1965. She was the head of the firm’s derivatives practice and represented domestic and international clients in legislative, litigation, regulatory, and transactional matters involving derivatives transactions and financial markets. Ms. Born also specialized in complex civil litigation and arbitration. She served on the firm’s Policy Committee and chaired its Pro Bono Committee and Associates Evaluation Committee.

    From 1996 to 1999 she was chair of the US Commodity Futures Trading Commission (CFTC), the federal government agency that oversees the futures and commodity option markets and futures professionals.

  19. @Paddy – bringing down USA economy ala virtual algorithms ends with a bullet in the forehead from HONEST LABOR.

    Capiche? Delusional drunken prick…

  20. Perhaps Paddy would favor us with a recitation of the social utility of those wonderful financial innovations developed since the 1990’s, and enlighten us as to the role they played in causing the financial system to collapse after September 15, 2008 for the first time since October 1929 in the administration of Herbert Hoover. There was 25 per cent unemployment, one-third of the nation ill-housed, ill-clothed and ill-fed, soup lines, bread lines, Hoovervilles and brother can you spare a dime. Perhaps Paddy could tell us how we had a safe and sound financial system for over six decades until we deregulated and reverted to Harding, Coolidge and Hoover. Please, please tell us.


    The Untold Story: Brooksley Born, Larry Summers & the Truth …
    Oct 5, 2012 … Larry Summers is attempting to re-write history at the expense of … and they might just find one critical point revealed in Mr. Cohan’s article.
    [PERTINENT EXCERPT]: Oct 5, 2012

    “As the western world wakes to the fact it is in the middle of a debt crisis spiral, intelligent voices are wondering how this manifested itself? As we speak, those close to the situation could be engaging in historical revisionism to obfuscate their role in the design of faulty leverage structures that were identified in the derivatives markets in 1998 and 2008. These same design flaws, first identified in 1998, are persistent today and could become graphically evident in the very near future under the weight of a European debt crisis.

    Author and Bloomberg columnist William Cohan chronicles the fascinating start of this historic leverage implosion in his recent article Rethinking Robert Rubin. Readers may recall it was Mr. Cohan who, in 2004, noted leverage issues that ultimately imploded in 2007-08.

    At some point, market watchers will realize the debt crisis story will literally change the world. They will look to the root cause of the problem, and they might just find one critical point revealed in Mr. Cohan’s article.

    This point occurs in 1998 when then Commodity Futures Trading Commission (CFTC) ChairwomanBrooksley Born identified what now might be recognized as core design flaws in leverage structure used in Over the Counter (OTC) transactions. Ms. Born brought her concerns public, by first asking just to study the issue, as appropriate action was not being taken. She issued a concept release paper that simply asked for more information. “The Commission is not entering into this process with preconceived results in mind,” the document reads.

    Ms. Born later noted in, the PBS Frontline documentary on the topic speculation at the CFTC was the unregulated OTC derivatives were opaque, the risk to the global economy could not be determined and the risk was potentially catastrophic. As a result of this inquiry, Ms. Born was ultimately forced from office.

    This brings us to Lawrence Summers, the former Treasury Secretary of the United States and at the time right hand man to then Treasury Security Robert Rubin. Mr. Summers was widely credited with implementation of the aggressive tactics used to remove Ms. Born from her office, tactics that multiple sources describe as showing an old world bias against women piercing the glass ceiling.

    According to numerous published reports, Mr. Summers was involved in. silencing those who questioned the opaque derivative product’s design. “

    ” …A POWER GRAB? ” ARE YOU ON Summers’ PAYROLE? This is what Summers attempted to initiate against Brooksley Born to cover his tracks just last year! Are you working his talking points?
    [Quoted Excerpt]
    “Here some neutral opinion from the article above that may address the questions you raised above:
    Mr. Summers comments in the William Cohen article are not only re-writing history to cover their tracks if the leverage implosion does occur, but they are trying to damage the reputation of a female pioneer whose only offense was pointing out appropriate issues with fundamental leverage issues that will likely impact all.

    Was this the First Warning Mr. Summers Ignored?

    In addition to time spent fighting Ms. Born over transparency and risk management issues unregulated derivatives, Mr. Summers was also influential in the operation of the Harvard University pension fund. Sources deep in the derivative industry say that Mr. Summers was given a warning about the Collateralized Default Swaps (CDS) in which Harvard had invested. The CDSs were a structurally different product than what Ms Born warned against, but again carried many of the same fundamental derivative design flaws.”

    “This is the guy [Summers] that lost something like 20-30% of the Harvard endowment fund investing in CDOs–the very crap that Born would have been ‘regulating.’ Iris [Mack] warned Summers of this and she was summarily fired.”

    Please read the real history…and the entire article and stop acting out like an Irish Troll !

  23. No Mr. Sullivan, it is much more culpable to find out precisely what Summers said …and did…in 1998.

  24. You haven’t been paying attention? We know what Summers said and did in 1998; he, and the other grown ups, cut Brooksley’s scheme off at the pass. For very good reasons.

    Now, find something FROM BACK THEN that shows his reasons were wrong. If you can.

  25. Born is the one who was reaching for a “power grab”??!!


    How can you say that with a straight face – it’s so ludicrous.

    The ONE person who was standing in the way of the PLAN to grab it all – the blood lust of Summers et al – is the power grabber.

    And that’s the problem that exists in the “NOW” – ONE person empowered to forever rule as the “ME ME ME” in the holy holy holy equation of the money lenders:

    More misery for other = More $$$$ for ME ME ME

    NO ONE gave the control of currency over to the Pharisees. They TOOK it through force and fraud as if we are still living swinging through the trees.

    Gandolph in LOTR to the monster, “You shall not pass”.

    No one cares anymore, Paddy. You’re all going down….JUST WAR planning changed a bit considering that the gangs in the city ‘hoods are protected by some “secret” Pharisee SPY APPARATUS to act as the FORCE in making sure that the moon-walking Middle Class stays put down beneath them….yup, only the current Supreme Court will rule against a person who shoots a rabid raccoon heading for its ankle…a FACT which adds to the justification for a JUST WAR – lest you forgot – cut and pasted from wiki:

    “…The Just War theory is an authoritative Catholic Church teaching confirmed by the United States Catholic Bishops in their pastoral letter, The Challenge of Peace: God’s Promise and Our Response, issued in 1983. More recently, the Catechism of the Catholic Church, in paragraph 2309, lists four strict conditions for “legitimate defense by military force”:
    1. the damage inflicted by the aggressor on the nation or community of nations must be lasting, grave, and certain;
    2. all other means of putting an end to it must have been shown to be impractical or ineffective;
    3. there must be serious prospects of success;
    4. the use of arms must not produce evils and disorders graver than the evil to be eliminated. The power as well as the precision of modern means of destruction weighs very heavily in evaluating this condition….”

    Go ahead and keep arguing AGAINST “regulation” of the “aggressors”, and boil it down to a witch burning…

  26. You know, President Obama is a pretty intelligent guy in general. And when it comes to making decisions which are self-beneficial (or at least can bring him more attention which his narcissistic compulsions so badly crave for) he is a near master. But when it comes to presidential appointments you can pretty much rest assured that whatever is the MOST D-U-M-B-A-S-S choice available, the man will take it:

    Oh well, you know what Hillary says:

    And obviously Hillary is a “master” on state affairs. Just ask Richard Holbrooke. She took bows and curtain calls for all HIS work, and it’s not easy to arrive at just the all right moments to take credit for someone else’s hours of laborious negotiations when you’re busy stockpiling frequent flyer miles for international photo ops. You have to have excellent peripheral vision to pull that off.

  27. Playing the part of Obama: The Blonde

    Playing the part of Larry Summers: George

    Playing the part of the American people: Elaine

  28. This message brought to you by The Howard Stern, Chris Brown, and Mel Gibson Political Action Committee for Larry Summers:

  29. There was a question at the time whether swaps were futures. Because of this legal uncertainty, the Congress gave the CFTC authority to exempt many swaps from the provisions of the Commodity Exchange Act without determining whether or not the contracts were of the type covered by the CEA. The CEA does not define “futures contracts.” However, there was a category of of swaps for which the CFTC did not have legal authority to exempt if they were futures contracts. These were swaps based on non-exempt securities, such as total return swaps based on equity securities (credit default swaps were not a big factor at the time of the concept release). The reason is that the CFTC did not have the authority to exempt futures based on equity securities from the provisions of the CEA which codified the Shad-Johnson Accord of the early 1980s. This meant that if total returns swaps were futures contracts, then they were illegal and unenforceable and the CFTC did not have the authority to make them legal. This is what Treasury staff advising Secretary Rubin was worried about.

    It is fair to say that Rubin was probably more amenable to imposing additional regulation on the swaps market than was Summers at that time. Of course, many of the market makers were either commercial or investment banks and subject to either bank or SEC regulation (in the case of a broker-dealer). These agencies could have restricted swaps activities to the extent they viewed them as either adversely affecting the safety and soundness of banks or the capital of broker-dealers.

    Rubin offered a compromise to Brooksley Born because he did see risk in the swaps market. He wanted to make the Concept Release a joint product of the President’s Working Group on Financial Markets. If she had agreed, this would have put Chairman Greenspan in a difficult position. But she said no.

    I have written a number of posts on my blog about this. Here is one post:

  30. I have no real quarrel with what you wrote above, Norman. However, in your April 2010 blog post, where you say;

    ‘While, not to make too fine a point about it, she [Brooksley Born] has been proven right and Greenspan wrong about the dangers of the OTC derivatives market, Greenspan was the better politician.’

    that’s clearly wrong. The derivatives in question back in 1998-99 were foreign currency and interest rate derivatives (CDS being nearly non-existent then), and as far as I know there has been no problem with them. I.e., the actual concerns of Brooksley Born did not eventuate; Summers and Greenspan were right, and she was wrong.

    Unless you know of some evidence otherwise.


    like derivatives were the only thing driving the complete transfer of wealth from the “NOW” of Main Street to the virtual and delusional world of “god’s chosen” doing “god’s verk”….

    what a LOAD of hooey – never going to admit to the iniquity, are you all?

  32. Thanks, James, I am sore afraid of Summers as FED head. But, as to derivatives and their regulation, they still aren’t, an oversight (intentional) of the latest round of regulation. As to Born, I strongly agree with what she advocated. Obviously their are certain areas of derivatives that need little attention. But, given that, perhaps as much as 80% of the derivatives presently generated in the tens of thousand per month, definitely need to be regulated and publicly traded. The proper regulation of these could be crafted to enable proper regulation without impairing the important forms which have existed for many decades and serve a good purpose.

  33. @Norman Carleton

    I don’t get your argument here. The Concept Release Issued by the CFTC under Born addressed the OTC derivatives under its jurisdiction. See II.A.2 of the Release and footnote 9.

    To the degree that total return swaps (TRS) were excluded from the CFTC’s jurisdiction by the Shad-Johnson Accord, they were a separate issue from the OTC swaps under the CFTC’s jurisdiction that were covered by the concept release. Why would the Treasury secretary interfere with the CFTC’s regulation of the financial products under its jurisdiction because of putative concerns over a sub-category of products that did not fall under its jurisdiction?

    The argument makes no sense.

    You write: “There was a question at the time whether swaps were futures.”

    This is incorrect because it is too broad. For a huge number of swap categories the law was settled. They were futures. The fact that there was a tiny sub-category of swaps that may not have been futures does not mean that the law was unsettled for every other product.

    “The CEA does not define “futures contracts.”” But the law at the time did define futures contracts via judicial precedent and binding administrative decisions. (see p. 14).

  34. The implication of the concept release was that OTC swaps were either futures contracts or commodity options otherwise the CFTC would not have jurisdiction and the concept release would have been pointless. If an instrument similar to a total return swap but not based on non-exempt securities were deemed to be under the CFTC’s jurisdiction because it was a futures contract, then that strengthened the argument that total return swaps were futures contracts. If they were, then they would be illegal futures contracts.

    This was the threat that hung over the OTC derivatives market. The people in the business decided to grow the OTC derivatives market in spite of this legal uncertainty and were successful in getting the Congress to pass laws giving the CFTC the authority to exempt OTC derivatives that might be futures from provisions of the Commodity Exchange Act, including the requirement that they trade on a futures exchange. The CFTC exemptive authority did not extend to the Shad-Johnson Accord provisions, which had its own exchange-trading requirement for futures on stock indices and prohibited futures on single non-exempt securities.

    Having been present at many discussions at the time concerning what constitutes a futures contract was far from clear. A broad interpretation might have captured all sorts of instruments that no one would think should be subject to CFTC jurisdiction, such as foreign currency traveler checks and leases tied to a measure of inflation.

  35. You write “Having been present at many discussions at the time concerning what constitutes a futures contract was far from clear.”

    Legal terms are always subject to some dispute at the margins. (Common first year law cases discuss when is a cow not a cow and when is a chicken not a chicken.) Despite disputes at the margins, there is typically, as with cows and chickens, a wide range of situations where the meaning of the term is undisputed. Thus the issue is not whether there was dispute over what a futures contract was, but what was the appropriate range of the dispute given existing legal interpretations.

    I also don’t understand how the answer to the question of the appropriate range of the dispute could possibly be given by an economist who lacks the legal training to evaluate the case and administrative law on this issue.

    “If an instrument similar to a total return swap but not based on non-exempt securities were deemed to be under the CFTC’s jurisdiction because it was a futures contract”

    Where does the Concept Release attempt to bring “an instrument similar to a total return swap” under its jurisdiction or to address this question in any way? I understand that this issue may have been a concern for the financial industry. What I don’t understand is what the Concept Release has to do with this problem.

  36. Born process would not have invalidated or otherwise canceled any derivative contracts. Her method simply would have created sunlight on how big the exposure was on the whole OTC derivative market, which we now know grew explosively from the 1990’s into the disaster of 2008.

  37. Although I find Mr. Carleton’s comments to be very educational and beneficial to the general discussion, me thinkest someone is being too much of an apologist for his former boss. I think there is little doubt (little as in NONE ) that Robert Rubin was playing major strong arm intimidation tactics with Miss Born. And other than Rubin, I have yet to hear anyone say otherwise. We’re supposed to believe that the posterboy for deregulation under BIll Clinton’s watch and THE Citibank’s crony of Citibank cronies was ready to sign on to the Concept Release???

    Mr. Carleton says: “He [Rubin] wanted to make the Concept Release a joint product of the President’s Working Group on Financial Markets. If she had agreed, this would have put Chairman Greenspan in a difficult position. But she said no.”

    Question #1 for Mr. Carleton: Why would Robert Rubin need Miss Born’s “yay or nay” for a section of a release made by the President’s Working Group on Financial Markets??? PWGFM was Rubin’s show, lock stock and barrel—what the hell would Born’s “No” mean?? Much more likely it was Rubin’s attempt to water down and control the wording of the Concept Release. HER AGENCY’S RELEASING THE CONCEPT RELEASE WAS NONE OF RUBIN’S OR GREENSPAN’S DAMNED BUSINESS TO BEGIN WITH!!!! This seems to me the rhetorical equivalent of a Boss telling his secretary “Well, I don’t want to get up and walk across the office to get my coffee, is it ok with you if we go and get the cup of coffee together??”. What in the hell was she going to say at that point??? The close confidant of the U.S President, croniest crony of bank cronies, and U.S. Treasury Secretary is asking the female head of an agency long ago castrated by Republican Senator Phil Gramm and his wife “Is it ‘ok with you’ if we make your Concept Release a joint product of the PWGFM???” THE MESSAGE WAS CLEAR.

    Mr. Carleton, with all due respect to your intelligence Sir, IF (that is a BIG “IF” capital I, capital F) you believe Treasury Secretary Rubin “asked” this question to Miss Born, you are not qualified to discuss who is good or bad at politics (between Greenspan and Miss Born). And your word “amenable” to describe Mr. Rubin on this issue is pure unadulterated bullsh*t

    Question #2 for Mr. Carleton: Who was your Politics 101 professor at University??? You might keep who it was quiet to save he/she embarrassment.

  38. Detailed Summation:
    By Moira Herbst, Monday 12 August 2013 12.14 EDT
    comments (86)
    Larry Summers’ record should rule him out of the Fed chairmanship.
    Why would we want a key advocate of the banking deregulation that brought us the great recession to head the Federal Reserve?

    As Chief Economist, Summers stated in a 1991 interview: “There are no… limits to the carrying capacity of the earth that are likely to bind any time in the foreseeable future. There isn’t a risk of an apocalypse due to global warming or anything else. The idea that we should put limits on growth because of some natural limit, is a profound error and one that, were it ever to prove influential, would have staggering social costs.” This statement is regarded as highly controversial by ecologists and other sustainability scientists.”
    In December 1991, while at the World Bank, Summers signed a memo that was leaked to the press. Lant Pritchett has claimed authorship of the private memo, which both he and Summers say was intended as sarcasm
    DATE: December 12, 1991
    TO: Distribution
    FR: Lawrence H. Summers
    Subject: GEP

    ‘Dirty’ Industries: Just between you and me, shouldn’t the World Bank be encouraging MORE migration of the dirty industries to the LDCs [Least Developed Countries]? I can think of three reasons:

    1) The measurements of the costs of health impairing pollution depends on the foregone earnings from increased morbidity and mortality. From this point of view a given amount of health impairing pollution should be done in the country with the lowest cost, which will be the country with the lowest wages. I think the economic logic behind dumping a load of toxic waste in the lowest wage country is impeccable and we should face up to that.

    2) The costs of pollution are likely to be non-linear as the initial increments of pollution probably have very low cost. I’ve always thought that under-populated countries in Africa are vastly UNDER-polluted, their air quality is probably vastly inefficiently low compared to Los Angeles or Mexico City. Only the lamentable facts that so much pollution is generated by non-tradable industries (transport, electrical generation) and that the unit transport costs of solid waste are so high prevent world welfare enhancing trade in air pollution and waste.

    3) The demand for a clean environment for aesthetic and health reasons is likely to have very high income elasticity. The concern over an agent that causes a one in a million change in the odds of prostrate[sic] cancer is obviously going to be much higher in a country where people survive to get prostrate[sic] cancer than in a country where under 5 mortality is 200 per thousand. Also, much of the concern over industrial atmosphere discharge is about visibility impairing particulates. These discharges may have very little direct health impact. Clearly trade in goods that embody aesthetic pollution concerns could be welfare enhancing. While production is mobile the consumption of pretty air is a non-tradable.

    The problem with the arguments against all of these proposals for more pollution in LDCs (intrinsic rights to certain goods, moral reasons, social concerns, lack of adequate markets, etc.) could be turned around and used more or less effectively against every Bank proposal for liberalization.
    —Lawrence Summers, [6][7]

  40. @Woych – ASTOUNDING ignorance about “reality” – SCIENCE – from Summers. It reads like a Monty Python skit – it is so stupid – and would be hysterically funny except for the fact that Summers has so much “faith” in himself and his, uh, original interpretations of stuff like air particulates.

    What a tool….

    The NEED for a Union of Ethical Scientists to slam down C-suite is the only way to avoid a bloody civil war with the empowered scumbag global class of “rich” – Global War Drug and Slave Lords. You KNOW that they did not get global rich from moon-walking projects….

  41. I am not a lawyer and I know, to use the technical term, jack shit about the issue. However, I think that Born clearly did *not* have the authority to grandfather existing contracts. The law was clear — CDS (et cetera) either were or were not subject to CFTC regulation. the CFTC had (and has) no authority to choose which among the things it may regulate it does regulate. If it may, it must. The problem was that the earlier chair (Wendy Gramm) had unlawfully assured people that contracts which she and the CFTC were required by law to regulate were OK no probs no regulation.

    With no new laws there were only three choices. Either to follow W. Gramm (and impose the commodoty futures modernization act by lawless executive order) or to hand the problem over to P. Gramm (and accept the commodity futures modernization act with at least the decent form of an act of congress) or to invalidate existing contracts entered into in good faith.

    Clinton was stuck between two Gramms. He had to invalidate existing contracts or choose between Gramm and Gramm. Clinton, Summers, Rubin, Born and (imagining he were less lunatic than the Gramms) Greenspan could not thread needles. They could go to congress or congress as the courts would have said that the law said what it clearly said which was that existing contracts were invalid.

    Now Summers went on to advocate a Gramm acceptable law. Rubin did no such thing. Your observation that Rubin did nothing, when the only thing he could possible have done was invalidate contracts which were signed in good faith, is uncharitable in the extreme.

    Rubin’s actions are defensible. Gramm’s, Gramm’s, Greenspan’s, Summers’s and Clinton’s are not.

  42. ‘… the earlier chair (Wendy Gramm) had unlawfully assured people that contracts which she and the CFTC were required by law to regulate….’

    What law is that, specifically?

  43. The law of gravity.
    Part 1:
    Repoed! How The Fed And Depositors Fund Banks’ Big Bets by Colin Lokey
    Repoed, Part 2: A Deeper Look At Banks’ Source Of Dry Powder by Colin Lokey

    Repoed, Part 3: Proof Deposits Are At Risk And A Disappearing Act Explained by Colin Lokey
    The Leveraged Buyout Of America by Ellen Brown

  44. As usual, Bruce, your remarks are completely irrelevant. The law in question is the CEA (Commodity Exchange Act) and the amendments to it over the years. Someone has already put up a link to a GAO report on one of those ‘amendments’ the Shad-Johnson Accord, from which;

    ‘The Shad-Johnson Jurisdictional Accord may have limited investor choice
    and has exposed market participants to legal uncertainty.’

    Right there we have a refutation (‘legal uncertainty’) of Mr. Waldman’s claim. Not to mention that the disagreement has nothing to do with mortgage backed securities, or credit default swaps;

    ‘Although investors can use stock-based options and equity swaps to hedge price risk, they cannot use stock-based futures to the same extent because of the accord trading prohibitions. Also, according to futures industry officials, the accord has limited the ability of U.S. investors to use foreign exchange traded stock index futures to hedge the price risk associated with their foreign stock investments. Finally, counterparties to equity swaps have faced legal uncertainty because of the potential for such swaps to fall within the judicially crafted definition of a futures contract… and thus become subject to claims of illegality and unenforceability under the [Shad-Johnson] accord.’

    There’s that ‘legal uncertainty’ again.

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